New FDI policies create confusion in retail industry

By Shardul Thacker, Mulla & Mulla & Craigie Blunt & Caroe

India has so far not allowed any foreign direct investment (FDI) in the multi-brand retail industry, due to internal political opposition to the entry of multinational retail giants. Voices both within and outside government fear that such entry could ruin the livelihood security of small traders and a large number of people who are employed in traditional forms of retail business.

While infusion of 100% FDI in cash and carry (business to business) retail is currently permitted, only 51% FDI is allowed in single-brand retail. FDI in multi-brand retail has been expressly prohibited under FDI policy.

Multi-brand retail giants like Wal-Mart, Carrefour and Tesco have been compelled to either take the franchise route or provide technical (back-end) services only; some have even chosen to wait until the policy is completely changed to meet their requirements.

Shardul Thacker Partner Mulla & Mulla & Craigie Blunt & Caroe
Shardul Thacker
Mulla & Mulla & Craigie Blunt & Caroe

Initial changes

On 13 February the government of India issued press notes 2 and 3 of 2009, changing the FDI policy to exclude indirect foreign investment in domestic Indian companies from the overall sectoral ceiling limits of FDI, so long as the entity making the downstream investment is “owned and controlled” by Indians (resident Indian citizens and persons resident in India as defined by the Foreign Exchange Management Act).

Ownership (including beneficial ownership) is here defined as having more than a 50% shareholding in the investing Indian entity, while control means the power to appoint the majority of directors and legally direct the board’s actions.

“Beneficially owned” was also defined to ensure that shares that are owned by Indians in the beneficial interest of foreigners will be treated as foreign investment. This meant that non-resident entities willing to accept a minority interest in a joint venture (JV) in India could carry on economic activities that are restricted or capped under FDI policy by undertaking downstream investments.

However, press notes 2 and 3 also stipulate that if the investing Indian company is foreign-owned and controlled, then its entire downstream investments will be considered indirect FDI, with an exception that if the foreign-owned and controlled Indian company undertakes downstream investments in 100% owned subsidiaries, the amount of indirect FDI will be equal to the percentage of foreign investment in the Indian investing company.

Although press notes 2 and 3 put to rest the debate on computing FDI (direct or indirect) in sectors in which limits apply, it implicitly allows FDI in all sectors and industries which have sectoral caps or restrictions, through the downstream route described above, as long as the foreign investor is content to have a minority interest in the investing Indian company.

Reactions and clarification

The new FDI guidelines were very well received by prospective foreign retail investors and multinational brands, as it now appeared possible to enter the multi-billion dollar Indian retail industry through the back door: setting up a JV (with minority foreign holding and board control) in India, and investing downstream by setting up further subsidiaries or JVs. Such investment is not categorized as indirect FDI and so does not breach the FDI prohibitions on multi-brand retailing.

However, faced with stiff political opposition to FDI in the multi-brand retail industry, the government then used press note 4 of 2009 to clarify that FDI cannot enter India through a circuitous route. The guiding principle is that no more FDI can be made indirectly through downstream investments than can be made through direct FDI.

This came as a blow to prospective players wanting to enter the Indian retail market. Direct FDI in multi-brand retail is prohibited under FDI policy, and by application of press note 4’s guiding principle, indirect FDI in multi-brand retail is also prohibited, notwithstanding the enabling provisions of press notes 2 and 3.

Press note 4 means that indirect foreign investment must now also comply with the relevant sectoral conditions on entry routes, conditions and caps with regard to the sectors in which the companies are operating.

A domestic firm in which investment is made by another Indian company (which itself has a foreign holding or board representation) will be subject to the sectoral conditions on entry route, and other restrictions of FDI policy.

Press note 4 seems to defeat the entire rationale and purpose of press notes 2 and 3, leaving advisers and investors confused over the intentions of the government in a time of financial turmoil.

As fears of diminishing foreign fund flows into India are beginning to be realized, the government has begun to seriously think about revisiting its new policy on FDI in the retail sector.

Shardul Thacker is a partner with Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.


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